Sigma-Aldrich Corporation Q2 2009 Earnings Transcript

Sigma-Aldrich Corporation (SIAL)

Q2 2009 Earnings Call

July 23, 2009 11:00 AM ET

Executives

Kirk Richter - Vice President and Treasurer

Rakesh Sachdev - Senior Vice President, Chief Financial Officer and Secretary

Jai Nagarkatti - Chairman, President and Chief Executive Officer

Analysts

Quintin Lai - R.W. Baird

Mike Sison - Key Bank

Dan Leonard - First Analysis

Amy Zhang - Goldman Sachs

John Roberts - Buckingham Research

Dmitry Silversteyn - Longbow Research

Jon Wood - Bank of America/Merrill Lynch

John Shane - Shane & Co.

Presentation

Operator

Good morning. My name is Anthony and I will be your conference operator today. Today's conference is being recorded. At this time, I would like to welcome everyone to the Sigma-Aldrich's Second Quarter 2009 Results Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks there will be a question-and-answer session. (Operator Instructions).

At this time, I will now turn the conference over to Mr. Kirk Richter, Treasurer and Investor Relations contact. Please go ahead, sir.

Kirk Richter

Thank you, Anthony. And let me also have good morning and welcome to our second quarter earnings conference call.

With me today are Jai Nagarkatti, our Chairman, President and CEO, and Rakesh Sachdev, our CFO, who is joining us from Asia today.

After my introductory comments, Rakesh will review our second quarter performance and full year 2009 outlook. Jai will follow that with comments on our performance, the market conditions and more color on our full year 2009 outlook.

After completing those reviews we'll open up the call for your questions and comments. We will be using a slide presentation as part of today's call. That presentation can be viewed by accessing our Investor Relations website on sigmaaldrich.com.

Before we begin these reviews, I do need to remind you that today's comments will include forward-looking statements about future activities and our expectations for sales, earnings, cash flow and other possible future results.

While we believe these expectations are based on reasonable assumptions, actual results may differ materially due to any number of factors, including the risk factors listed in our Annual Report on Form 10-K for the year ended December 31, 2008, and in the cautionary statement that is included in today's release and in our slides.

We have no plans to update these forward-looking statements after this conference.

Also, as SEC regulations require us provide information on any non-GAAP financial measures covered in today's conference. That information, which consists of currency and acquisition-adjusted sales growth, profit and EPS results on both, the pro forma and reported basis, and free cash flow, reconcile the net cash provided by operating activities, is also contained in today's earnings release, which is posted on our website.

Now, I ask Rakesh to begin our review. Rakesh?

Rakesh Sachdev

Thanks Kirk, and good morning.

As we reported in today's release, second quarter sales were $522 million, improving slightly on the 519 million reported for this year's first quarter. And our second quarter net income of 84 million and diluted EPS of $0.68 matched our first quarter performance.

Currency was again a significant factor, with reported sales 10% or almost $59 million below last year's second quarter. The adverse impact of currency reduced reported sales by 8%.

An organic increase in research sales of 1.5 of 1% was more than offset by a 7% organic decline in our SAFC sales, producing an overall decline in organic sales of 2%. That's due in part to the timing of the Easter holiday in 2009, compared to last year in 2008.

Our second quarter net income exclusive of a $13 million currency impact was up 7% from last year’s second quarter as we delivered on our promise to seek process improvement benefits and manage costs to offset those impacts, Finally our diluted EPS for the second quarter was $0.68 compared to $0.70 last year’s second quarter. This reflects a 70 basis point improvement in both operating and pre-tax profit margins from last year's levels.

Excluding the negative impact of currency, diluted EPS would have been $0.79, representing a 13% increase. I will have more comments on our sales and income result shortly.

Finally, we added another $73 million to our free cash flow in the second quarter to bring the year-to-date result to $159 million, putting us on track to achieve the previously forecast free cash flow for all of 2009 to be in excess of $300 million.

A $23 million international tax payment in the second quarter partially offset by an improvement or a reduction in performance of working capital was the major change in free cash flows, between the first two quarters of 2009.

With the timing impact of Easter this year in the second quarter, it's helpful to look at results for the first six months to accurately judge our performance, so far in 2009.

Excluding a 9% currency impact on sales, our organic sales performance matches what we achieved in the first six months of 2008. You may really be asking what that indicates about our belief that we can achieve low single-digit organic sales growth for all of 2009.

I'll address that when I review the sales results for our research and SAFC businesses. Our year-to-date reported net income reflects the continued impact of currency that was more than offset by benefits from our supply chain projects, lower SG&A costs, and pricing actions.

Our diluted EPS grew even faster than net income, with the help from our share repurchases that provided a $0.03 benefit in the second quarter, and a $0.06 benefit year-to-date.

Consistent with our prior forecast, our plan for 2009 is to achieve low single-digit organic sales growth. While the second quarter performance was challenging due in part to the sales increase experienced in last year's second quarter, and the impact of Easter this quarter, we believe this expectation is achievable for the full year particularly, since we'll be compelling to a weaker 2008 second half.

We also indicated that we plan to maintain our earnings per share slightly above 2008 levels. We believe that we demonstrated that with our year-to-date performance, and fully believe that performance can continue in the final six months of this year.

Let's now review our sales performance for the second quarter and the first six months of 2009. Several factors contributed to the organic growth in research sales of 0.5% in Q2 compared to the 3 plus percent organic sales gain we realized in the first quarter.

The primary factor is the timing of the Easter holiday this year, versus last that had an impact that we estimated at between 1 to 2%.

Each of our three research-based businesses units, experienced roughly the same reduction from Q1 to Q2. Excluding that, we don't believe that this change, from Q1 to Q2, reflects any significant change in the research markets we serve, and we fully expect performance to normalize and rebound in the second half of the year.

We saw some indication of that stronger performance in all markets in June. We did achieve a $10 million increase in SAFC sales in the second quarter over our first quarter level. But that, Q2 increase was masked by an even stronger gain in 2008's second quarter over that year's first quarter.

So the performance in Q2 relative to Q1 doesn't appear as strong. But that's the nature of this business, with quarterly variations being somewhat the norm.

Within our four key focus areas in SAFC, we also saw somewhat inconsistent performance between the first two quarters of the year. Our Biosciences, Pharma and Hitech businesses all saw higher sales in the second quarter than the first quarter, offset by a modest decline in our supply solution sales.

In all cases that's against the strongest quarterly performance since 2008. But performance in upcoming quarters is expected to rebound, as we saw our booked orders for future delivery increase again, with the second quarter increase of 19% building on the first quarter again of 16%.

As you can see in our margin analysis, our overall pre-tax margin for the second quarter improved by 70 basis points from 22.6% in 2008, to 23.3% this year.

And our year-to-date margin was up 130 basis points, based on an even stronger performance in this year's first quarter.

Currency was again a significant headwind for us during this quarter, and reduced our second quarter margins by 1.6%. More than offsetting this, were contributions from our supply chain initiatives, reductions in SG&A expenses, and lower interest expense driven by lower rates.

As indicated earlier, our cash flow continued to be a strength. And we are on track to again generate more than $300 million in free cash flow in 2009. Our investment and working capital continues to be a focus, reducing that cash used by over $30 million from last year's first six months. The timing of an international tax payment in the second quarter offset that.

We are on track to spend roughly $110 million for capital in 2009. Consistent with what we reported a few months ago, we have not encountered any change in our ability to play a short-term debt in the U.S. or any of the international markets.

We feel we have a strong balance sheet and have sufficient cash and borrowing capacity to adequately fund our operations and make selective acquisitions later in 2009 and beyond.

Our performance expectations for all of 2009 remains consistent with what we reported at the end of the first quarter. Organic sales growth is expected to be in the low single-digits. At current rates, currency will likely reduce that by about 5%, slightly below the 8% impact that we reported one quarter ago.

On profitability, we continue to believe that we can deliver diluted EPS for 2009 above the record $2.65 we reported for 2008. We expect our EPS in the second half to largely match our first half performance.

That guidance is based on our sales expectations, continuation of our cost improvement efforts, current exchange rates. And our belief that our markets will not change much from what we have experienced in the first six months of 2009.

We expect currency will remain a strong headwind, but our supply chain activities and cost management activities are expected to offset a currency impact based on current rates in excess of $0.40.

Now, I will ask Jai to complete our review with comments on the drivers of our second quarter results, current market conditions and more support for our 2009 forecast. Jai?

Jai Nagarkatti

Thank you, Rakesh, and good morning, everyone. Let me start by saying that I'm pleased with our second quarter performance in this challenging economic climate.

As we had expected, we saw some softening of sales across all research segments of our business, due to the timing of Easter holidays in the quarter. And as we had mentioned during our first quarter conference call, we believe that the results for the first half of 2009 are a better indicator of our performance, and are also the basis for our expectations for the remainder of the this year.

Notwithstanding a slow organic sales growth in the second quarter, we continued to see positive impact from a number of initiatives launched in the first six months and even during the past few weeks.

Let me review just a few highlights of our accomplishments in the second quarter that we believe provide support for our full year expectations.

Sales to our e-commerce channel rose to a new high of 45% of research sales, up from 44%, just one quarter ago, as we launched new initiatives and increased content on our website.

We saw increased traffic to our site, following the first quarter launch of the new version of YFG or Your Favorite Gene. The Your Favorite Gene search, which is powered by Ingenuity, provides researchers with a comprehensive knowledge, based of gene pathways and biological information, which are all linked to our products.

We were delighted to learn that YFG was recognized in June with the 2009 CIO award by the CIO magazine. This award recognizes the innovation and business value of linking science with information technology. This tool and other online tools we have added, establish us as a premier resource for life science researchers, seeking information that allows them to better understand complex biological systems.

A few years back, we made a major commitment to expand our product offering in targeted areas within our research biotech unit. We added 2,300 new antibodies in the second quarter to bring our prestige line of validated antibodies to over 6,100 products and our total antibody offering to over 20,000.

The information on these products has also brought new traffic to our website. The platform technology of zinc fingers licensed from signed mobile sciences, enabled us to develop new tools to edit the genome in living cells.

These products are being leveraged in normal ways in a wide area of applications, such as an IPS or adult stem cells, protein production and cell engineering, and in developing animal models. And there is some very exciting news in this area coming soon, so please stay tuned.

On our initiative to grow sales at a faster pace in emerging economies, we continued to make good progress, as we expand our service and presence in these countries. Though still small, we are seeing a great reception in both Chile, where we increased our presence earlier this year, and in Vietnam, where we established a presence last year.

Our expanded distribution center in China should be opened in August, enabling us to enhance our ability to provide unsurpassed service to customers in this fast growing economy.

Excluding the impact of currency, sales growth in the CAPLA countries, exceeded other geographic regions with an 8% gain in research sales, up slightly from the 7% achieved in this year's first quarter.

In our focused markets of India, China and Brazil, overall organic growth in the second quarter was 9%, with improved organic sales growth of 16% in India, exceeded by an even higher growth of 39% in Brazil.

Sales in China improved by over 6% from the first quarter 2009 levels, but we are matched against a very strong 2008 second quarter performance.

Within our SAFC unit, we continued to see increases in our booked orders for future delivery. Booked orders increased by 19% at June 30 from their March 31, 2009, level to another all time high. These include some significant orders from several large pharma accounts for products to help produce vaccines for the H1N1 flu pandemic.

As we have said in the past, these orders don't provide the majority of sales for any quarter or year, but do provide some insight about future sales. So what do we expect SAFC's reserves to be for the full year of 2009.

As you are likely aware, it was our SAFC business that experienced the brunt of economic impact in the first half of 2008. Based on the increase in booked orders and their expected delivery, we now expect SAFC to make a modest overall contribution to our low single-digit organic growth expectations for all of 2009.

As were seeing the currency adjusted declines experienced in the first half of 2009.

Finally, our supply chain initiative continues to be a significant contributor to our improved profitability and ability to offset the currency headwind. We achieved another $7 million in pre-tax benefits in the second quarter, coupled with our cost management initiatives, and a contribution from our share repurchase program, we were able to offset a majority of the $0.11 per share currency impact on our second quarter earnings per share.

Now, that now brings me back to our forecast for 2009. Let me provide a few more details on the expectations that Rakesh already shared with you.

I've already indicated that SAFC sales are likely to a modest contributor to our expectations of a low single-digit increase in organic sales. Since we don't know what the benefit might be from the stimulus of stem cell funding initiatives in the U.S., or their timing, no benefit has been included in this forecast from these initiatives.

Our research business will likely deliver organic growth consistent with the 2% realized in the first half of 2009, with the majority of this coming from our price initiatives.

So we are comfortable with our overall forecast for a low single-digit increase in organic sales. As Rakesh said earlier, currency will likely be about a 5% headwind to that growth, if rates remain at June 30, 2009, levels, reducing our overall reported sales below prior year levels.

With a modest improvement in foreign exchange rates at June 30 from the March 31 levels, the currency headwind at the EPS line won't be quite as significant as previously predicted.

But we are also likely to incur some of the expenses deferred in the first half in the areas of advertising and maintenance.

We still keep a tight control on all discretionary spending and push productivity levels, until business volumes improve and currency isn't a drag on our earnings. So I remain comfortable with our forecast of diluted earnings per share above last year's $2.65.

The outlook is a bit more encouraging than it was one quarter ago. And we are committed to delivering these sales growth and EPS expectations.

Let me conclude by stating that based on our first half performance, we are lot more confident about our ability to do just as well in the second half, in terms of earnings per share. Which, we believe will be supported by slightly stronger sales in the second half, our continued focus on implementing supply chain initiatives, and a less negative impact from foreign exchange rates, if rates remain at June 30, 2009 levels.

I want to thank you for your ongoing interest in our company. We continue to be a leader in the life science and high technology markets we serve, and have the financial capacity to make investments needed to take share in these markets.

We remain committed to deliver superior returns for our employees and our investors. On behalf of Rakesh, Kirk and all our colleagues around the world, I want to thank you for joining us this morning.

Now, let's open up the call for your comments and questions. Thank you.

Question-and-Answer Session

Operator

Thank you. The question-and-answer session will be conducted electronically. (Operator Instructions). We will take our first question from Quintin Lai at Baird.

Quintin Lai - R.W. Baird

Hi, good morning and good evening, Rakesh.

Rakesh Sachdev

Good evening.

Quintin Lai - R.W. Baird

Jai, could you kind a break out a little bit more in terms of some of our market, your end market demand with respect to academic and big pharma and some of your industrial accounts?

Jai Nagarkatti

Yeah Quintin, good morning. See, as we have said, I think our markets in the research business are pretty well evenly split at third in the academic account, third in the form of both large and small, and then the other third in the industrial accounts. That's basically the split.

Now if you, if your question is how is the performance of all of these three groups within the second quarter...

Quintin Lai - R.W. Baird

Yeah.

Jai Nagarkatti

I would say the academic accounts continued to be doing just fine, even though there is some slowness because of the Easter holiday, we didn't see much change.

Pharma continues to struggle, and we did see a little bit of a slowdown in the industrial accounts.

Quintin Lai - R.W. Baird

Okay. And then, earlier today, one of your competitors talked about the pacing through the quarter. April was down and kind of -- but then picked up through May and June. What was your experience as the quarter went through. And then with respect to your daily sales, are you seeing a return to more normalcy, or do you see some days of still lots of volatility?

Jai Nagarkatti

I think this is a very interesting phenomenon that we have noticed this year particularly, Quintin. And as the months progress in the second quarter we saw increasingly robustness and strength in the demand with June for us being probably the strongest month this year.

So that makes us little bit more confident that perhaps, things are beginning to rebound. And as you pointed out, we do watch the order volume, even though its still not at last year's level. We are seeing promising improvement month-by-month.

Quintin Lai - R.W. Baird

Great. Thank you. I'll jump back into to the queue.

Operator

We'll take our next question from Mike Sison at Key Bank.

Mike Sison - Key Bank

Hey, good morning guys.

Jai Nagarkatti

Good morning.

Mike Sison - Key Bank

In terms of SAFC, I just wanted to get a better understanding of your outlooks, Jai, the contributions that is going to have for your organic sales growth go single-digits, is that to suggest that positive in the second half of the year, year-over-year versus turning positive for the full year?

Jai Nagarkatti

That is year-on-year Mike.

Mike Sison - Key Bank

All right.

Jai Nagarkatti

And positive.

Mike Sison - Key Bank

So for the full year '09, the strength that you're seeing for the second half of the year gets it to positive?

Jai Nagarkatti

Correct, yes.

Mike Sison - Key Bank

And how much of the weakness that you saw in the second quarter, was due to, I mean, we've seen a lot of semiconductor chemical related businesses have issues year-over-year, and as the improvement that you're seeing, maybe stand from some good improvement there, heading into the second half of the year?

Jai Nagarkatti

No. I think again, as we said, it is in the pharma sector that we are seeing a significant improvement in the booked order backlog. And again, coming -- commenting on the second quarter, I want to remind you that I think the second quarter actual overall SAFC business was stronger in terms of actual dollars, compared to the first quarter.

But when you compare it against the 2008 second quarter, which was again a very strong quarter last year. It looks weak.

Rakesh Sachdev

Yeah. I can put little more color on that. In the second quarter, when you look at the pharma and the Hitech business, our Hitech business that's really tied to the semiconductor industry was down quite a bit less than what we saw in the first quarter.

So we actually saw some improvement in both those sectors in SAFC in the second quarter and also the first quarter.

Mike Sison - Key Bank

Okay. And then final question, I think the outlook figure organic sales growth is certainly surging. The outlook for foreign currency it sounds like you've held it down. The negative hit then in 2009 its going to be less.

I think you know the $0.50 in the last quarter and now its going to $0.40. So I would, I guess, the question is why wouldn't your earnings outlook be a little bit stronger given that foreign currency is less than. And is there something that on an operational basis that goings to pull back the optimism?

Rakesh Sachdev

Well, let me take that question. This is Rakesh. So you are right, I mean at the last call, we talked about a $0.50 headwind. Now we have said its going to be somewhat in excess of $0.40 in the low $0.40.

So, if we just look at FX we would pick up somewhere around the 5 to $0.06, compared to what we said a quarter ago. But I think we have also elected to increase some spending in certain areas in our SG&A.

Particularly, as you have heard Jai say, there are certain areas of sales, and some of the IT stuff that we want to do for our future. So we will use that to fund some of the expenses that we did not get into the first half into the second half. So that's going to have some offsetting impact to the currency tailwind that we might get in the second half.

Mike Sison - Key Bank

Okay, great. Thanks guys.

Operator

We'll take our next question from Dan Leonard of First Analysis.

Dan Leonard - First Analysis

Hi, good morning.

Jai Nagarkatti

Hi Dan.

Dan Leonard - First Analysis

A question on your research essentials business. That business is the only one of your businesses that's actually tracking better in 2009, versus 2008 on an organic basis. Why is that so strong?

Jai Nagarkatti

Dan, this is Jai. Let me take that. I think the thing is, I think, again our business really is built on our ability to source products and service products. And this year, we benefited from that, because there were certain products, especially, in the HPLC solvent area, where there was demand and supply issues, and we were able, and we still are able to get, to get, procure high quality material and service that particular market, when some of our competitors maybe struggling. And that is contributing and contributed in the first quarter to the research essentials growth, particularly in the U.S.

Dan Leonard - First Analysis

Okay. And I have another question are currency as well. So if the exchange rates stay at current levels, we'll actually see a current tailwind in the fourth quarter and then in 2010. Should we assume that did you spend that tailwind, which has being practice in the past.

Jai Nagarkatti

Rakesh, you want to give the feedback?

Rakesh Sachdev

Yeah. You're right. If the currency remains where it goes at the end of June that we said. We will have some tailwind for the balance of this year compared to what we have said at the last call. But again as we all know, currencies are fairly volatile and we're not giving guidance for 2010.

We have elected, at least for this year to use some of that for some of the spending we would like to do. But that's not to say that that benefit will be used for additional spending in 2010.

Dan Leonard - First Analysis

Thank you.

Jai Nagarkatti

Okay.

Operator

We will take our next question from Amy Zhang with Goldman Sachs.

Amy Zhang - Goldman Sachs

Thanks. Good Morning. My first question is about your supply chain benefit, and year-to-date do you realize that $13 million, I think that's a pre-tax of savings. I think a back in March or April investor day your target of 15 to $20 million annualize the benefit in 2009. So I am just wondering, shall we expect some upside to your previous target.

Rakesh Sachdev

Well hi Amy, this I Rakesh I believe that even at the last call we have devised that we were saying that we were feeling like that the supply chain benefits this year could be in the range of $30 million.

We have to got close half of that in the first half and we are still are feeling pretty good that we get to above that number for the full year and that built into our forecast

Amy Zhang - Goldman Sachs

Got you. Thank you. And my second question is your total cap to that ratio looks a pretty value in this quarter is a below 30. I think typically you guys talking about a comparable level as 30 to 35%.

So I'm wondering how to address your annual average balance sheet going forward. Are you going to probably step up your efforts and show by buyback or probably look for some acquisitions or what's your strategy?

Jai Nagarkatti

Amy to continue to look for opportunities for acquisitions, our plans for share buyback at this point are just offset dilutions from our equity award program. So, I don't think we are concerned that we are slightly below, or roughly one third goal at this point. And still out there looking for opportunities to grow our business through acquisitions.

Amy Zhang - Goldman Sachs

Got you. And then my last question is the growth, organic growth in a CAPLA countries now is a high single-digit. And given some rebound in economies in those regions. Would you expect accelerating growth in the second half of this year?

Jai Nagarkatti

Yeah Amy this is Jay. I think a couple of points here I think even though it looks optically that high single-digits. In some countries like I mentioned in my, India for example and Brazil are doing extremely well. China, which is the other focus country we are up against at very, very strong second quarter of last year, where people where in retailers in China where building up inventory in preparation for the Olympics. And to remember the third quarter is there that China sales were low.

So overall that 1 or 2% debt compared to a double-digit growth that we have seen in the past, is not an issue it should come right back up.

Amy Zhang - Goldman Sachs

Thank you so much.

Operator

And we will take our next question from John Roberts at Buckingham Research.

John Roberts - Buckingham Research

Good morning, guys.

Rakesh Sachdev

Good morning John.

John Roberts - Buckingham Research

Currency effect was $0.13 cents in the first quarter, 0.11 in the second. How does the remaining $0.16 spread between the third and the fourth quarters?

Rakesh Sachdev

Currency slightly weighted to the third quarter. But there will be an impact in both quarters. Because as you recall the past, some of it has to go through inventory and that's the more significant impact that we see. So we'll be split equally the third quarter will be slightly higher, there will be an impact in both quarters.

John Roberts - Buckingham Research

And then secondly, in the response to the last question on China, should we expect an outsize, kind of very high percentage gain in the third quarter here, because of the easy, much easier comparison.

Jai Nagarkatti

I think if they are looking at the numbers compares rates continue, the way that which we have seen in the first and the second quarter against the weaker comparable third quarter you are correct.

John Roberts - Buckingham Research

Okay. And then Jai, I thought you mentioned that your industrial segment actually slowed a little bit during the quarter over in SAFC. I thought electronics was -- electronic materials were the largest component of that. In a lot of electronic material companies actually saw acceleration in the quarter. I did not know if there is some disconnect there between your business and the general market.

Jai Nagarkatti

No I think my comments to the earlier question was industrial accounts in general for both the research and not specifically for the SAFC part.

John Roberts - Buckingham Research

Okay. How about the electronics of the industrial side?

Jai Nagarkatti

Again, if I put in context our SAFC's supplies to hitech business is still a very small piece, and most of the products are still going in development application that very small in the commercial one. So when commercial things turn it doesn't have a big impact of moving the needs one way or the other.

John Roberts - Buckingham Research

Okay. Thank you.

Operator

We take our next question from Dmitry Silversteyn at Longbow Research.

Dmitry Silversteyn - Longbow Research

Good morning. Most of my questions have been answered. But I just want to make sure I understand and I admit that right now I don't. What are you doing to drive your margins to the level that you are able to improve them.

And I will frame at this way, for years you have been basically keeping margins flat almost regardless of what was happening with currency. In 2007, and 2008 it was evolved the 22.5% range falls amount of 20 basis points.

You have this program that was supposed to increase the margins by 1.5 over three years and here you are in the course of six months, improving your margins by about 2.5 points, if you subtract 1.5 impact from currency.

So how much of this is temporary where is just delaying spending that you have to do in the second half of this year or in 2010 and how much is permanent and structural and then the question is why haven't you done it sooner if you were able to do it now.

Jai Nagarkatti

Let me address that I think John. As I told you sometime back that implementing the supply chain initiatives that expectations are to expand our margins by 150 basis points. If we put all the 18 related initiatives in place by 2012. Obviously, we have pulled some of these things forward, because of the current economic situations.

The first half as you know, we got realized almost $13 million and expect something that is similar in the second half. Now some of these cost control things are sustainable and as indicated earlier, some savings are achieved from deferring and delaying as well, discussion with spending. And the routine projects like maintenance and replenishments, replacements where we can get by pushing it a little bit further have been delayed. So we will actually be spending as Rakesh pointed out a somewhat larger amount in the second half of this year. So the question is referring and delaying, so I think there is a certain basic cost that one has to incur to maintain a complex organization like ours.

John Roberts - Buckingham Research

Right. So in other words, if you are pulling forward the settings assure hoping to get by 2012, it sounds like you're going to be largely done within by 2010. Should we or by 2009. Should we assume them that as you recover and your organic growth returns to more normal level that you are going get a significantly better than 1.5 extension in margin, in normal life conditions then you originally looking for.

Rakesh Sachdev

But I think John, I think one of the other thing is that I think we are in this for the long haul. So we'll have to make some investments that we've been deferring. So I think our commitment was for 150 basis point by 2012, I think we'll sustain that over the long.

Dmitry Silversteyn - Longbow Research

Okay. So we should see as the economic conditions recover at permitting investment to improve your sales, we should see the level of spending increase maybe faster than that is what it sounds like.

Jai Nagarkatti

Slight more yes.

Rakesh Sachdev

Okay. If I can add just a couple of comments John, I think the improvement at the gross margins level are largely sustainable, because we're making structural changes and the improvements we're making to our supply chain is hopefully going to be sustainable. That's what we're aiming for.

I think the reductions in our SG&A spending as I said at the last call, we estimate that at least 70% of other reductions that we have achieved some where in that order would be sustainable at least in the near term. And there as Jai said that there are fewer expenses that we deferred, that we are going to bring back because we are thinking about the long term and we have to prudent about not deferring things for too long.

Dmitry Silversteyn - Longbow Research

Okay. But you're not, in your opinion you are not doing anything to jeopardize the long term growth of your company.

Rakesh Sachdev

Absolutely not.

Dmitry Silversteyn - Longbow Research

Okay. Thank you.

Operator

We will take our next question from Jon Wood from Bank of America/ Merrill Lynch.

Jon Wood - Bank of America/Merrill Lynch

Hey, good morning.

Jai Nagarkatti

Good Morning John.

Jon Wood - Bank of America/Merrill Lynch

Jai, going back to --we should assume basically that SAFC for the year is over 2% organic growth is that accurate?

Jai Nagarkatti

Its brings us, Jon, it will be probably with all of the other bookings that we are seeing in shipping. It will probably be slightly positive I wouldn't let's say be low single digits. Yeah.

Jon Wood - Bank of America/Merrill Lynch

Okay. So, basically you are looking at about an eight or so percent increase in the back half of the year. And so obviously with orders related to the Flu, that gives you some confidence but can you discuss what exposure SAFC has to the M&A situation at Pharma and specifically with the development projects, are we at a point where you feel like the projects you have in that business are stable?

Jai Nagarkatti

Yeah. I think we have -- as you rightly pointed out SAFC business is a project oriented one. We expect to compete for other opportunities as well beyond the products for H1N1. Overall I think what one can expect is many other projects that we have been with the Pharma accounts in the development phase, as time progresses some of these are beginning to go into latter stage projects where the quantities, that would be needed should also ramping up.

So we are counting on some of that because we do have insights and get some of that information from our customers. So that's the one factor. The second one as I mentioned is the bookings of some of this H1N1 related products. And the third aspect is comparables. 2008, the last quarter and the third quarter to some extent for SAFC was very weak, compared to the first half. So going against a weaker second half in general should also help the comparables.

Jon Wood - Bank of America/Merrill Lynch

Okay. Understood. So the mix from a self manufacture versus sourced perspective, is it accurate to say that the mix has changed this year? And I'm just referencing the comments on the shortages in the essentials business. Have you seen basically a real shift in your mix?

Jai Nagarkatti

Not significantly. The overall mix is pretty well the same.

Jon Wood - Bank of America/Merrill Lynch

Okay. And then last Jai, just a comment on the M&A pipeline. Are things starting to progress at all from the freeze, I guess in the first half of the year, I mean you are seeing more opportunities or bigger opportunities at this point.

Jai Nagarkatti

I think the M&A pipeline has always been -- there is no significant change first of all in sellers' expectations due to the change in the market conditions. So we continue to be interested and we keep looking and reviewing opportunities that come our way. And we are also looking at opportunities in a proactive way in areas where we are focusing and believe that there are opportunities.

As we've said before these have to meet some of our very specific criteria. They had to have a strategic rationales for doing the deal with realistic valuation. So stay tuned.

Jon Wood - Bank of America/Merrill Lynch

Okay. Thanks a lot.

Operator

And we'll take our next question from Isaac Ro with Leerink Swann.

Unidentified Analyst

Hi this is Jyoti Rai (ph) for Isaac, can you guys hear me?

Jai Nagarkatti

Yes.

Unidentified Analyst

Okay, thanks for taking our questions. First of all you previously stated a goal of lowering inventories from seven months to six months. So what are the two to three key factors to achieving that goal?

Rakesh Sachdev

Yes so this is Rakesh. So we are working on our number of fronts and in fact one of the initiatives within our supply chain group is to address the inventory, that we have. And we are looking at a number of things. I mean it's not just one. We're looking at different brands. We are looking at our distribution consolidation. I think there are things that over the long term will have a more significant impact. In the short term we'll continue to make some improvements and we are making improvements. But, I think once we make some more structural changes we will see some additional benefits in inventory. But it's clearly an area that we are very, very focused on.

Unidentified Analyst

Okay. Thanks. And secondly what was the volume growth in the second Q and the first half of '09? And what do you think the volume growth will be for the full year versus your guidance of low single digit organic growth?

Jai Nagarkatti

You want to take that.

Rakesh Sachdev

I think as we said earlier, volumes were actually down. The organic gain we saw for the first half of the year was largely price related. So volumes are actually down a couple of percent. We'd expect particularly on the SAFC side to see that turnaround in the second half of the year and as Jai said earlier we got a much easier comp. Their level of sales that we hit in the second quarter of roughly 146 million was equivalent to what we achieved in the fourth quarter of the last year on SAFC. So with the extra business that Jai talked about we expect the SAFC volumes to be very positive in the second half of the year.

Unidentified Analyst

Okay. Thanks. And lastly do you guys see any order delays in waiting for the stimulus funding now so far and do you expect to see any related delay in the third Q? And are you seeing any benefits from the non healthcare stimulus funding, thanks?

Rakesh Sachdev

First, what we are expecting we don't know really when those funds are going to be released. We didn't see a major impact in the second quarter. We know a lot of folks were busy writing grant applications in April and May, but we didn't see a major change in activity. As we said earlier June was certainly a good month. But we haven't baked in any expectations from stimulus money. So to the extent that some of it come our way, that would suggests that we increase our guidance a bit, but since we don't know how to do that today we have not done that.

Unidentified Analyst

Okay, thanks.

Operator

(Operator Instructions). We'll go next John Shane at Shane & Co.

John Shane - Shane & Co.

Hi guys my question is about the short term guidance commercial paper. There is a -- looking at the most recent release and prior 10-Q there's about a point 411 million in that debt due in the year, about another 200 million that matures in the next 18 months. 75% of that 400 million looks like its commercial paper is that -- it holding commercial paper, rather then longer term funded debt, should we as investors think of that as the long term part of the capital structure. And I guess behind that question is the thought that you guys have a wonderful business franchise and as we observe in the capital markets lately are a little tapped -- earlier you had something around -- sometime the commercial paper market is very unfriendly to everybody sometimes it becomes unfriendly to individual companies, if there are issues in this company. So, I'm wondering how you guys think about this the risk involved with commercial paper as opposed to longer term funded debt and how you think investors should think about that.

Rakesh Sachdev

We probably have an interesting challenge in working it harder to keep that mix. We've tended to be slightly longer in commercial paper. I think and as we said earlier our comments we've had no trouble placing our commercial paper. In fact our commercial paper is backed up by bank lines that certainly have the ability to place commercial paper we could then draw on those bank lines if we needed it. But our other challenge is to recognize the fact that we do generate in excess of 300 million in free cash flow per year. And we want to make sure that we don't have cash beyond needs either. So that's why we tip a little bit in the short term direction, recognizing that operations does provide a significant amount of cash on an annual basis.

Unidentified Analyst

Well, I'll ring off. But I was sort of chuckling when the Goldman Sachs analysts said you guys are under leveraged. That was an obviously default that deeply reflected the analysts community but from a long term investor community not their shareholder, our clients for nine or 10 years, I'd say that less would be better and you guys are doing a great job and thanks very much.

Jai Nagarkatti

All right, thank you.

Operator

(Operator Instructions). We go next to next Derik de Bruin at UBS.

Unidentified Analyst

Hi this is Rob Bail filling in for Derik. How are you? Just a couple of questions here. You mentioned that the SAFC market remains stable while the industrial and Pharma markets remain a little bit more difficult. I am just wondering what your best guess on the turnaround for post investment from the market and what sort of indicators are you assessing to kind of figure out when we should be seeing this turnaround?

Rakesh Sachdev

Two things I think we have to look at the dynamics for the research business separately than the fine chemicals. Fine chemicals for SAFC what's happening in the Pharma and the industrial, especially in the second quarter is promising and we hope that, that is a sign that things may be loosening up and turning the corner. As far as the research is concerned I think the Pharma sector because of the large consolidations that you will have seen in the first half of this year, that brings a temporary sort of paralysis until things settle down. Over the long haul, we have seen, based on our past experience that things settle down and work gets back to normal.

So I think our hope is I think towards the later part of this year, especially based on the volumes that we see from the large Pharma it should begin to stabilize.

Unidentified Analyst

Regard the dimension of consolidation, what's your assumptions for your current pricing power. Is there potential that we should have there?

Jai Nagarkatti

I think pricing this for the research business is not really an issue has not been an issue. I think we can continue to stick with our plan of low single-digit pricing especially, as input raw materials go up, we can actually get a little bit more price.

Unidentified Analyst

And one final question. Just you mentioned the impact of these or they how factor -- this quarter? Just wondering if you is there is any other items that we should be on the look out for in the second half of '09?

Jai Nagarkatti

Not necessary. They use their holiday, the reason we talk all this out is, because of really fault in the quarter. And it impacts a greater portion of our customer base both in Europe and in the U.S. I don't foresee or have a situation like that that I can give an example for going forward.

Unidentified Analyst

Okay. Thanks, I'll get back in the queue.

Operator

With no further questions in the queue, I would like to turn the conference back over to management for any additional or any closing remarks.

Kirk Richter

We certainly thank everybody for their participation today. Looking forward, we do expect to release results for the third quarter of 2009, before the market opens on October the 22nd. And we'll then again follow that with the conference call that same day at 10 o'clock time. This concludes today's conference.

Operator

This concludes today's presentation. Thank you everyone for their participation.

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

If you have any additional questions about our online transcripts, please contact us at: [e-mail]. Thank you!